Magazine

Saying No To An LBO

July 22, 2007

Not long ago, billionaire investor Carl C. Icahn's bid for Lear Corp. (LEA) would have been a slam dunk. The $36-a-share offer, disclosed on Feb. 5, was 80% higher than the stock price a few months earlier. And both the board and Chief Executive Robert E. Rossiter had given their blessing.

But within days, Classic Fund Management, a big investor, sued to block the deal, arguing Rossiter had personal motives for pushing it. The court sided with the plaintiffs. As part of the ruling, Lear had to reveal to shareholders that Rossiter had asked the board to cash out his $11.6 million retirement plan; he later decided not to move forward after consultants said it would alarm investors. The Icahn deal would trigger that payout and allow Rossiter to keep his job. In an opinion on June 15, Delaware State Court Vice-Chancellor Leo E. Strine Jr., who stopped short of blocking the deal outright, noted that Rossiter didn't act improperly but said the deal "presented him with a viable route for accomplishing important personal objectives." Says Lear's general counsel: "We weren't trying to hide anything." Icahn has since upped his bid to $37.25, and the vote is set for July 16. "We think we're paying full price," says Icahn.

Battles like the one at Lear are playing out across the private equity landscape. In recent months shareholders have become increasingly hostile toward managements and boards for accepting what they perceive to be lowball bids, and they have been aggressively filing suits to block deals. Such tactics are nothing new. The difference now is that investors are starting to win. "You're seeing real skepticism," says Kenton J. King, an attorney at Skadden, Arps, Slate, Meagher & Flom. "Judges are asking if there isn't something else going on, other than getting the most value for shareholders."

With the buyout boom turning into a frenzy, private equity firms are feeling pressure from all sides. Politicos are bashing the group's big pay packages and beneficial tax treatments. Trade unions are complaining about the layoffs that often follow deals. Now judges are scolding CEOs who seem to be teaming up with private equity players at the expense of shareholders. The growing backlash comes at a time when borrowing costs are rising and firms are fretting that the bargains are gone. With investors and judges also pushing private equity to boost bids, it raises the likelihood that the current wave of deals will deliver meager returns, if not losses.

The Delaware courts took a bat to the buyout plans of Topps Co. (TOPP). In March, Michael D. Eisner, former CEO OF Walt Disney Co. (DIS), and Chicago private equity firm Madison Dearborn Partners signed a deal to acquire bubble gum and trading-card maker Topps for $9.75-a-share, or $385 million. Three weeks later rival Upper Deck Co. submitted a $10.75 bid to the board. But Topps' board said in a statement that such a merger might raise antitrust concerns and argued that Upper Deck hadn't proved it had enough financing to fund the deal. The company scheduled a vote for Eisner's offer.

The courts, though, decided investors needed more details about potential conflicts. Strine, the same judge in the Lear suit, ruled in mid-June that Topps needed to disclose two previous bids by Upper Deck. He also said management should tell investors that Eisner planned to keep Topps' management in place. CEO Arthur T. Shorin would stay on as a consultant, while Scott Silverstein, his son-in-law and the company's current president, and others would have a spot at the company--assurances Upper Deck didn't make. "Shorin has known that time is running out for him," Strine wrote in his recent opinion. "He was motivated to find a buyer that would guarantee that Shorin and his son-in-law would continue to play leading roles at Topps."

After getting the go-ahead from the courts, Upper Deck contacted shareholders directly on June 25 with a formal offer for the company. Topps, which still opposes such a merger but is currently in discussions with Upper Deck, hasn't moved forward with a vote yet. Topps declined to comment.

"DIFFERENT SET OF MOTIVATIONS"

The buyout boom has proven to be fertile ground for litigation. While shareholder suits overall are down, those involving private equity firms have doubled in past three years, according to insurance broker Marsh Inc. (MMC).

And judges don't necessarily have to weigh in for suits to be effective. Last year, as a result of litigation, hospital giant HCA Inc. agreed to cut the termination fee it would pay buyers, from $500 million to $220 million, in the event the deal fell through. Shareholders then approved the buyout. On June 10, Affiliated Computer Services Inc. (ACS) suspended an exclusive agreement with Cerberus Capital Management for a $6.1 billion buyout and agreed to solicit other bids; Affiliated must now reimburse Cerberus $7.5 million for expenses plus $15 million if the company goes to another firm. Suits had alleged that Affiliated's chairman was trying to take the company private on the cheap. Affiliated declined to comment.

In one case, a judge has even refused to sign off on a settlement already approved by shareholders. Last November, Delaware Vice-Chancellor Stephen P. Lamb took William C. Stone, founder and chief executive of SS&C Technologies Inc., to task for negotiating with Carlyle Group without first letting the board know he was shopping the tech outfit around. In the deal, Stone sold some of his shares for cash and traded the rest for a larger stake in the soon-to-be private company. "A manager who has the opportunity to take $72 million in cash from the transaction and roll a portion of his equity into a larger [share] in the surviving [company] has a different set of motivations than one who does not," Lamb wrote in his opinion.

In the end, Lamb rejected a proposed settlement agreement on behalf of shareholders, citing concerns about the original buyout. A jury trial is scheduled for next July. Says Stone: "I firmly believe that we got top value for shareholders, and our position will be sustained."

Indeed, Stone, CEO of a private SS&C, doesn't seem fazed by the continued turmoil. In mid-June he filed with the Securities & Exchange Commission to sell shares to the public, 19 months after he took the company private.